Tax on severance is an important aspect of the law for employers and employees to understand. The Basic Conditions of Employment Act, No. 75 of 1997 (BCEA) provides that an employer who dismisses an employee for ‘operational requirements’ must pay severance of one week’s remuneration for every completed year of service. However, this does not prohibit an employer from providing more than the statutory minimum in terms of a contract of employment, company policy, collective agreement or an agreement reached in terms of s189 of the Labour Relations Act, No. 66 of 1995 (LRA).
The Minister of Finance has increased the tax-free threshold from R315 000 to R500 000, applicable from 1 March 2014. However, this amount remains a lifetime exemption. Therefore, should an employee have the misfortune of being retrenched more than once in their working life, this person may continue to claim the tax exemption on the severance component, but only up to a ceiling of R500 000, after which tax will be payable. According to the South African Revenue Service (SARS), it is the responsibility of the employer to apply for a tax directive should such severance be payable.
It must be noted however that this benefit does not apply to pro-rata bonus, severance notice and leave as the aforementioned remain subject to tax. Therefore, the circumstances under which one will be entitled to this severance benefit must comply with the definition of a ‘severance benefit’ as defined in the Income Tax Act, No 58 of 1962 (Income Tax Act). The Income Tax Act provides that a severance benefit means any lump sum amount received from an employer in respect of the relinquishment, termination, loss or repudiation of office or employment or of the person's appointment or a right or claim to be appointed to an office, provided one of the following requirements are met:
- The person is 55 years or older.
- The person is incapable of holding employment due to sickness, injury or incapacity.
- The termination or loss is due to one of the following:
- The person’s employer having ceased to carry on or intending to cease carrying on the trade in respect of which the person was appointed; or
- The person having become redundant in consequence of a general reduction in personnel or a reduction in personnel of a particular class by the person’s employer (ie retrenchment or due to general operational requirements).
In light of the above, it would seem that on a plain reading of the definition, it suggests that should a 55-year-old employee’s employment be terminated for whatever reason, the severance benefit will apply.
Accordingly, there may be argument and it seems as though that should a 55-year-old employee's employment be terminated (for no reason related to operational requirements as required in the BCEA), severance benefits (ie the tax-free threshold) may find application.
In conclusion, this threshold affects a broad category of employees should their employment be terminated and it is therefore important for employers and employees to note that the severance benefit will be tax free up to the first R500 000 payable and thereafter the benefit will be taxable.